Kenneth Petersen: Money left over in 529 college savings plan

Q: I read your recent Herald column on 529 plans. I find myself in the enviable position of having, as a result of academic scholarships, a fairly large sum of leftover money in my 529 plan. I was hoping you could include some thoughts on how to retrieve that money without having to pay extraordinary penalties and tax. It is my understanding that others are facing this dilemma.

A: Yours is a good problem to have. Here are some ideas:

1. The IRS makes exceptions on the additional 10 percent tax you have to pay on distributions that you do not use for qualified education expenses. These exceptions include distributions you take and include in your income because the designated beneficiary received a tax-free scholarship or fellowship.

You should check with your tax adviser to see if you qualify for this exception. If you qualify you will pay income tax on the earnings portion of your distribution but you will not have to pay any penalty.

Other exceptions include distributions made because the designated beneficiary received veteran's educational assistance, or employer-provided educational assistance, or other nontaxable payments other than gifts or inheritances received as educational assistance. Another exception is for distributions made if the designated beneficiary attends a U.S. military academy.

2. You can keep the 529 plan and change the designated beneficiary to one of the current designated beneficiary's family members. Eligible family members include a son, daughter, stepchild, foster, adopted child, any descendant of one of them; a brother or sister or stepbrother or stepsister; the father or mother or ancestor of either; a stepfather or stepmother; son or daughter of a brother or sister; a brother or sister of the designated beneficiary's father or mother, in-laws of the designated beneficiary; the spouse of any of the above; and a first cousin.

You could also just keep the 529 plan the way it is now until you have a grandchild, and then designate him or her as the beneficiary. If you as the owner die while owning the 529 plan, the successor owner that you selected will take ownership and appoint a new successor. If you have not selected a successor owner, the designated beneficiary will become the owner.

3. You can transfer ownership of many 529 plans, including California's Scholarshare plan. The new owner can appoint a new successor owner to serve upon his disability or death, and can also change the designated beneficiary to a family member of the current beneficiary.

If your intent is for the new owner to use the money for college education expenses, then you should have trust and confidence in the new owner, who will always have the option to simply cash out, pay the penalty and taxes, and keep the difference. In some cases it is possible to transfer ownership to an entity such as a trust, corporation, or partnership. You should only transfer ownership with guidance from your attorney and tax adviser.

Q: Can I leave my 529 plan to a charity or school?

A: Under current rules you cannot change the owner, successor owner, or designated beneficiary to a charity and it wouldn't make sense to change the owner to a charity anyway because of the beneficiary family tree rules.